Bernanke Capitulates, Launches De Facto Nominal GDP Target

The only way the unemployment rate can get back to 6.5% is to close the output gap, which remains extremely wide.

MINYANVILLE ORIGINAL At the April 2012 FOMC press conference, New York Times reporter Binyamin Appelbaum seemed to be channeling his inner Paul Krugman, asking Chairman Bernanke why the Fed was not doing more to bring down the unemployment rate (emphasis mine).

Appelbaum:

Inflation is under control, and you say that you expect it to remain under control. You say that you have additional tools available for you to use, but you're not using them now. Under these circumstances, it's really hard for a lot of people to understand why you are not using those tools right now. Could you address that?

Bernanke:

I guess the question is, does it make sense to actively seek a higher inflation rate in order to achieve a slightly increased reduction – a slightly increased pace of reduction in the unemployment rate? The view of the committee is that would be very reckless.

While Bernanke didn't come out and say it, he was tiptoeing around an idea that some economists have suggested that the Fed should be targeting a level of nominal GDP in order to close the output gap.

We have – we, the Federal Reserve, have spent 30 years building up credibility for low and stable inflation, which has proved extremely valuable in that we've been able to take strong accommodative actions in the last four or five years to support the economy without leading to an unanchoring of inflation expectations or a destabilization of inflation. To risk that asset for what I think would be quite tentative and perhaps doubtful gains on the real side would be, I think, an unwise thing to do.

When he said doubtful gains on the real side he seemed to be suggesting that stimulating nominal growth in an attempt to bring down unemployment was useless if it came at the expense of only higher inflation. In my mind this was big. This was perhaps the most hawkish thing Bernanke had ever said, and his response seemed to take a nominal GDP target off the table.

Back in July as Operation Twist was due to wind down, I raised the possibility that Chairman Bernanke was getting so desperate to bring the unemployment rate down faster that his QE nuclear option might take the form of a nominal GDP target to close the output gap. In Bernanke's Astonishingly Good Idea, I stated:

The idea of targeting NGDP would be to place an extrapolated dollar amount on the output gap based on a specified growth rate and the Fed would commit to tightening or easing based on where nominal growth deviated from that trajectory going forward.

If they launch QE3, whether they employ an explicit NGDP target or not, the objective is the same. In order to bring down unemployment the output gap must be closed, and the options for doing so without accepting higher inflation are dwindling. When Operation Twist ends they are effectively out of bullets, and to continue buying they will have to print. Despite what he said in April, if he continues to follow the path he outlined in 2002, the nuclear option could be a very real possibility.

As I forecasted back in July at Wednesday's FOMC announcement, Bernanke capitulated and opted to attach what are being called "thresholds" to the Fed's uber-easy and accommodative monetary policy by raising their inflation target to 2.5% in order to bring the unemployment rate down to 6.5%.